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Edward J. Balistreri, James R. Markusen
NBER Working Paper No. 13130
Issued in May 2007
NBER Program(s): ITI
IO
---- Abstract -----
We illuminate the relationship between optimal firm pricing and optimal trade policy by exploring a generalized model that accommodates product differentiation at both the national and sub-national (firm) levels. We assume monopolistic competition in the differentiated products at the sub-national level. When the national and sub-national substitution elasticities are similar we find little opportunity for small countries to improve their terms of trade through trade distortions, because firms play an important preemptive role in optimally pricing unique varieties. We contrast this with standard applications of perfect-competition Armington models, which exhibit high optimal tariffs--even for relatively small countries.
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